Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Dutch Bros Inc. (NYSE:BROS) does use debt in its business. But the real question is whether this debt is making the company risky.
Why Does Debt Bring Risk?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. If things get really bad, the lenders can take control of the business. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
How Much Debt Does Dutch Bros Carry?
As you can see below, Dutch Bros had US$240.1m of debt at June 2024, down from US$277.5m a year prior. But it also has US$262.4m in cash to offset that, meaning it has US$22.3m net cash.
How Strong Is Dutch Bros' Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Dutch Bros had liabilities of US$153.1m due within 12 months and liabilities of US$1.49b due beyond that. Offsetting this, it had US$262.4m in cash and US$12.3m in receivables that were due within 12 months. So it has liabilities totalling US$1.37b more than its cash and near-term receivables, combined.
Dutch Bros has a market capitalization of US$5.85b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk. While it does have liabilities worth noting, Dutch Bros also has more cash than debt, so we're pretty confident it can manage its debt safely.
Notably, Dutch Bros's EBIT launched higher than Elon Musk, gaining a whopping 196% on last year. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Dutch Bros can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. Dutch Bros may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. Over the last two years, Dutch Bros saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Summing Up
Although Dutch Bros's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of US$22.3m. And we liked the look of last year's 196% year-on-year EBIT growth. So we don't have any problem with Dutch Bros's use of debt. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. For example, we've discovered 1 warning sign for Dutch Bros that you should be aware of before investing here.
At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
